Leasing a Car

Leasing a vehicle from a dealer rather than buying it can seem like a fantastic option. In general, the payments are lower each month and you can often end up with a nicer vehicle to drive as well. But do those benefits outweigh the potential problems that can come with leasing?

Before you can answer that question for yourself, you need to know what leasing is (and what it isn’t), as well as the differences between leasing and renting. You also need to know the potential pitfalls that can come with leasing a vehicle. We’ve included all the necessary information regarding vehicle leasing here for you, so read on to see if leasing a vehicle is the right choice for you.

Vehicle Leasing Defined

Many people who have rented a vehicle in the past assume that vehicle leasing is very similar to vehicle renting. However, these individuals are incorrect, as the two are fairly different. Other people believe that leasing a vehicle is similar to renting an apartment, and that is actually true, but only to some extent.

Vehicle leasing is a way of financing a vehicle from a dealer, and in that respect it is similar to a car loan that you would take out when purchasing a vehicle. However, when you lease a vehicle, you are signing a contract that allows you to use the vehicle only for a specific amount of time. And unlike renting a vehicle, leasing involves taking the vehicle for a quite considerable length of time (rarely less than 24 months) and includes severe penalties if you decide to give back the vehicle before your contract is up.

When you lease a vehicle, you don’t actually lease it from the dealer. As previously stated, vehicle leasing is a form of financing, and when you sign the contract with the dealer, they actually sell the vehicle to a leasing company. Following this, you must deal with the leasing company when it comes to your payments and any problems you have with the vehicle.

Because the dealer is actually selling the vehicle to a leasing company, you as the customer need to understand two important things up front. The first thing is that you can negotiate the vehicle price, just as you would if you were buying the car directly. The second is that you can do some research and find the best leasing company for your vehicle. Most dealers automatically suggest that you use the leasing company that is connected to them, but you aren’t necessarily locked into that company at all. Some diligent research should help you find a company that can better serve your interests.

Leasing vs. Buying

Before you consider a lease, you need to know what the differences are between leasing a vehicle and buying one. As previously stated, the main difference is that buying a vehicle means you are financing the actual purchase of the vehicle, whereas leasing only enables you to use the vehicle for an agreed-upon period of time. There are other differences as well, however.

The first difference is that the cost of monthly payments will almost always be lower for a leased vehicle than for a purchased one. There is a simple reason for this difference in price. When you purchase a vehicle, you are paying for the entire cost of the vehicle (plus interest, taxes, title fees and anything else you’ve rolled into the loan). When you lease a vehicle, on the other hand, you are only paying for the depreciated cost of the vehicle during the time of the loan.

In other words, you’re paying the leasing company for the drop in value of the vehicle’s worth during the time you are using it. That amount will always be less than the total worth of the vehicle, so you pay a lower amount.

Second, when you are buying a vehicle you’re taking out a loan, whereas when you are leasing a vehicle you’re taking out a contract. At the end of a purchase loan, you own the vehicle. At the end of the contract, the leasing company owns the vehicle (as you’ve only been using it).

Don’t assume that because a lease is a contract that you can get one with a lower credit score, however. It actually generally works the other way — it’s easier to get a loan than to lease a vehicle. On the other hand, because a lease is a contract, you often have a stronger ability to negotiate any of the terms within it, which can lower your costs even further.

Third, there are some significant differences in how your payments work. With either a purchase or a lease, you can choose to put in a down payment and lower your monthly payments. But with a lease, you may also be required to give a security deposit on the vehicle to help cover any repairs when its returned — and you won’t get back that deposit, even if it’s not used. The deposit can be equal to a full month’s payment or more.

And speaking of payments, when you purchase a vehicle you make your first payment at the end of the first month you own the vehicle. In a lease, you always make the payment at the top of the month (because you’re paying to use the vehicle for that month). So you can end up with a significantly larger first payment when leasing instead of purchasing that vehicle.

Finally, you need to recognize that there are different costs associated with leasing or buying a vehicle. For example, most vehicle leases can be tied to the same length of time as the warranty of the vehicle, which can mean that most large repairs won’t cost you anything; if you purchase the vehicle, however, any repair costs after that warranty is over are yours to bear.

As another example, when you purchase a vehicle you can drive it as many miles as you’d like; with a leased vehicle, however, there generally is a limit to the number of miles you can drive it during the lease period, and if you drive it farther than that limit, you can expect to pay up to 25 cents for each mile. That can equate to quite a large payment at the end of the lease. Moreover, if the vehicle incurs more than normal wear-and-tear, you may end up having to make a payment to cover the excess depreciation on the vehicle.

Ultimately, the decision to lease or to purchase remains yours. If you want to lower your payments and change cars every few years, then it might be a good idea for you to lease the vehicle. If you want to actually own the vehicle at the end or are thinking of driving it for several years, you may be better off purchasing it.

Before You Meet the Dealer

Just like you need to do before making any other kind of large purchase, before you visit a car dealer for the purpose of finding a car to lease, you need to make certain you are ready to deal effectively. As part of this effort, be sure to get a copy of your credit report, as your FICO score can affect your lease price, the rate of the lease, and even whether you can get a lease at all.

Also make certain that you know the effective negotiating range for the vehicle you’re interested in. Just as you can when trying to purchase a vehicle, when you want to lease a vehicle, you can negotiate the price — and of course, a lower price equals a lower monthly payment. Remember to check out multiple dealers in your area who are offering your desired vehicle, and if you’re nervous about negotiating a price, you can look at online sites that will tell you appropriately discounted prices in advance.

Lastly, make certain you are ready to understand the contract you’re going to be signing. Read up on the terms you’re going to find in the contract so that you know exactly what you’re getting into when you sign on the dotted line. Even with federal and state laws in place that require them to essentially be transparent, dealers aren’t always as open as they ought to be. It’s your responsibility to be careful and ready.

Understanding the Contract

Couple Signing LeaseIn order to fully understand the contract that you will sign when beginning your vehicle lease, you need to know some specific terms, as well as what the contract will have on it. If you can, try and get a blank contract from the dealer before you sit down to negotiate — you’ll be glad you did, as you will be able to pore over it and look up anything that you don’t understand.

Within a lease contract, you’re likely to find the following items:

  • The disclosure statement – Required by the Federal Consumer Leasing Act, Regulation M (1998), this statement must, by law, include the following information:
    • The total amount that is due when you sign
    • Any extra charges added to the contract
    • The total number of payments that will be required
    • How the monthly payment is determined, including finance charges
    • The total amount in finance charges for the contract
    • The early termination process (this is what you go through if you want to get out the contract before it’s over; the cost to you for early termination will not be firmly established at the onset of the contract period, as that cost will change as the vehicle depreciates in value, but rest assured, it is always expensive to do an early termination)
    • The “wear-and-tear” explanation (this explains what the leasing company will consider normal wear-and-tear to be on the vehicle, as well as what you’ll pay extra if you return the vehicle at the end of the lease with more wear-and-tear on it than the company’s standard allows for)
  • The required amount of insurance – Although you are only leasing the vehicle, you must still maintain insurance on it. Because the vehicle is being leased, most leasing companies require a higher insurance policy than state minimums, usually $100,000/$300,000 death or bodily injury and $50,000 property damage and a comprehensive/collision amount equal to the value of the vehicle. The rationale behind this higher rate comes from the fact that the leasing company owns the vehicle and wants to get full value (and the lowest possible liability) if you damage the vehicle or anyone else’s.
  • The excess mileage penalty – As previously stated, if you drive a vehicle more miles during its lease than the contract allows (the allowance usually is for between 12,000 and 15,000 miles/year), you’re going to get charged extra for every mile over that amount. The contract will explain how much that per-mile charge will be.

While the contract will show you what the total finance charges are, it does not have to show you what the interest rate you are paying is — so make sure you ask for that directly. Note that in a lease, the interest rate is called a “money factor.” It will look very small (.002 or .004) but don’t let that make you think it’s not an interest rate. Multiply that small number by 24,000 and you’ll see that your lease has an interest rate that much more closely matches a normal interest rate.

You may also see a few other specific terms mentioned. For example, you may see something about the “residual value,” which is the estimated value for the vehicle when the lease is complete. This value is important because if you choose to buy the vehicle at the end of the lease, this is the price you’re likely to pay. If you see the term “capitalized cost,” that simply means the total amount you’re financing as part of the lease. And finally, the “capitalized cost reduction” is a fancy term for “down payment,” which can be in the form of cash or even a trade-in of your old vehicle.

Negotiating the Contract

Once you are ready to enter the dealership, remember that almost every part of the lease contract can be negotiated. You do not have to settle for the MRP (the sticker price) of the vehicle. You do not have to accept the first interest rate offer. You do not even have to accept the allowed mileage per year. This is a deal like any other negotiation and you are the buyer. You want to fight for the lowest down payment you can get, as well as the lowest interest rate possible. Anything else will cost you money in the end.

Things that can be negotiated include the following:

  • The price of the vehicle
  • The interest rate
  • The allowed mileage per year
  • The type and amount of wear-and-tear acceptable on the vehicle
  • The down payment
  • The warranty on the vehicle (if you want it to match the length of the lease)
  • The trade-in value of your old vehicle

Also recognize that if you walk into the dealership and announce you’re planning on leasing a vehicle, the dealers are much more likely to attempt to keep the price higher. So don’t be afraid to negotiate the price of the vehicle first and only announce that you’re going to lease it after that negotiation is already complete.

Finally, make certain that you ask the dealer about restrictions on driving the vehicle out of the state you reside in currently or about moving out of state (if you think that may happen during the lease). Some leasing companies have firm restrictions on driving a leased vehicle out of state (or simply a restricted length of time you can do so), and you don’t want to get stuck with an early termination penalty in the event you get a great new job three states away.

Gap Insurance

The type of insurance known as gap insurance warrants its own section because of its importance. If your vehicle is stolen or totaled during the lease period, that event counts as an early termination as far as the leasing company is concerned. Once this incident happens, your insurance will likely pay the leasing company for the vehicle. However, there may well be a difference between what the insurance company pays and the current value of the vehicle — and you’re going to be the one stuck paying that difference. This difference can be several thousand dollars.

In the modern world, such an event could easily happen, which is why gap insurance was created. Gap insurance covers that gap between what your insurance company pays the leasing company and what the vehicle was worth at the time of it being stolen or totaled. Some leasing companies require this gap insurance (and may ask for it all up front or spread it out amongst the payments). If they don’t require it, you should still seriously consider getting it anyway, either through the leasing company or separately. Anyone can have a serious accident or their vehicle stolen, and if this happens to you, you’ll already have enough on your hands without a bunch of extra money suddenly being due.

What Happens During the Lease?

During the lease period, you can drive the vehicle as you would normally — within limits. Always remember that you likely have a mileage limitation (although note that if the limit is, for example, 12,000 miles/year and the lease is for three years, all you have to do is make certain that when the lease is over, you haven’t gone over that 36,000-mile mark; if you go over the 12,000-mile limit one year, you can still balance that out the next year).

You will be required to pay for wear-and-tear on the vehicle and for any repairs that are necessary (although most major repairs should be free as the vehicle will still be under warranty). If you get a longer lease that extends beyond the warranty period, be ready to cover the cost of any repairs needed once the warranty period is over. If you live in a large city, also recognize that even the small, routine dings your car likely will receive might be more than the “wear-and-tear” section of your contract allows for.

If you end up with excessive wear-and-tear or do anything else that causes a level of damage to the vehicle which goes beyond the lease’s allowances, be ready to repair the vehicle before you return it. Otherwise, you could find yourself incurring a significant charge at the end of the lease.

Signing a LeaseWhat Happens After the Lease?

When the lease is over, you return the vehicle to the dealer. If your lease allows you to buy the vehicle and you wish to do so, you can then finance that purchase. If you are not going to purchase the vehicle, then it will be checked for wear-and-tear and for its odometer reading.

At this point, assuming you have maintained your vehicle correctly and driven with an eye towards the total mileage, you’re free to lease or purchase another vehicle. Do recognize that when the lease is over, you receive nothing back. If you gave a security deposit at the beginning of the lease, that will not be returned. You also have no equity in a vehicle — and no vehicle at all now.

However, if you’ve regularly made your lease payments on time and proven yourself capable of maintaining the vehicle correctly, your next lease is very likely to have at least equal terms to the previous one, if not better terms. For people who lease consistently, repeated leases at the same dealership can often drop interest rates and down payments as much as 30 percent.

Should You Buy the Vehicle at the End of the Lease?

Many leases allow you to buy the vehicle at the end of the lease. Whether you choose to do this or not is up to you, but there are some facts to consider before making a decision on this.

If you choose to buy the vehicle and sell it immediately to someone else, you can make a fair profit on the sale. The cost for you to buy the vehicle can be lower than the current market value for a used car with similar mileage and wear-and-tear (especially as you probably kept the vehicle in good shape throughout the time you were leasing it). The profit you make on the sale can translate into a new down payment on another lease or a vehicle you want to purchase.

But that profit isn’t always there. The cost to buy a leased vehicle is an estimate made several years earlier. Some vehicles end up depreciating in value faster than that estimate allowed for. This faster depreciation means you can end up finding the exact same model of car with similar mileage for a lower price elsewhere than what you’ll pay if you buy the vehicle you’ve been leasing.

If you’re considering buying the vehicle at the end of the lease, then, make sure you do some research in order to find what its current market value is. If you love the leased vehicle but the cost is cheaper elsewhere, you should return the vehicle and go with the more affordable option.

Some people fall in love with specific vehicles, however, and become very attached to them. If you happen to be one of those individuals, then you can certainly buy the vehicle you’ve been leasing, but know that if you buy it and keep it, you will ultimately have paid more money for the vehicle and the lease than you would have if you had simply purchased the vehicle to begin with instead of signing a lease contract.

Before you start leasing a vehicle, it’s not always possible, of course, to be certain of how you’re going to feel about the vehicle later on, but if you’re actually pretty sure you’re going to end up keeping the vehicle for many years, then it would probably be most prudent for you to just purchase it rather than lease it.

Other Things to Know

There are three other things you should know when it comes to vehicle leasing.

First, there is an advantage in leasing when it comes to the taxes you pay on the vehicle. If you purchase a vehicle, you pay taxes on the entire purchase price. If you lease it, however, you generally only pay taxes on the depreciated amount of the lease. This difference means you can pay as much as $1,000 less in taxes on a leased vehicle.

Second, be very aware of what happens in your state if the vehicle you lease happens to be a lemon. While most states have lemon laws, not every state has one that covers leased vehicles. If your state doesn’t cover such vehicles, your only option is to have the leasing company itself attempt to handle the lemon law requirements (as it technically owns the vehicle). Such a fight can be an enormous hassle as the leasing company expects to get paid regardless of whether your vehicle is drivable (and depending on the company, you may not have an easy way to fight such a battle in your state).

If the law in your state does cover leased lemons, then you can approach the vehicle’s manufacturer directly and, if you succeed in proving the vehicle is a lemon, will be allowed out of your lease contract (and may even get your payment money back). To find out if your state’s lemon laws cover leases, check out the “Buying a Car” article for your particular state here on Driving.com.

Finally, if you want more details on the laws concerning vehicle leasing or further details on specific aspects of leasing, the best place to start on the Internet is the Federal Reserve Board’s “Keys to Vehicle Leasing” Web page. The articles and links there can provide you with additional information and help you decide whether you should lease a vehicle or purchase one instead.